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An International Tax Shell Game

TDGonDP

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Brooks, Alberta
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In the early 1980s, I was working for an international oilfield service company. The company made no secret that it was about profits. All employees had reasonable access to their division’s financial summaries, which included both sets of books. I will explain that later.

I will just call this company ZZZZ International Ltd., which was, legally speaking, just a front for its many subsidiaries. Legally speaking, I was working for ZZZZ Canada Ltd. But ZZZZ Canada Ltd. was 100% owned by ZZZZ International Ltd. I believe there were at two subsidiaries based in the United States. I will just call them ZZZZ USA Ltd. and ZZZZ Manufacturing Ltd.. ZZZZ Canada Ltd. didn’t have a lot to do with “USA”, but it bought a lot of oilfield tools from “Manufacturing”.

ZZZZ Manufacturing was based in Houston. It was a medium sized factory that employed about 100 people, many of them machinists and electronic techs. They built much of the oilfield equipment for the ZZZZ subsidiaries around the world. ZZZZ Manufacturing did not have any customers outside of ZZZZ.

At that time, the corporate tax rate in the USA was lower than what it was in Canada. In order to minimize its taxes, ZZZZ International Ltd. would order ZZZZ Manufacturing to charge a BIG premium to ZZZZ Canada for oilfield tools. When I saw the two sets of books, an oilfield tool that cost $5,000 to manufacture in Houston was priced at $30,000 for ZZZZ Canada Ltd. That is a six-fold premium. By being charged so much for in-house manufacturing, ZZZZ Canada Ltd. was really not in a profitable situation to pay much Canadian corporate tax.

So how could a company with profit as a motivator actually justify keeping the Canadian operation going. Here’s how: they kept a second set of books that were based on the actual cost of the tools. ZZZZ Canada Ltd. was actually reasonably profitable. These profits were extracted into the USA through the overpriced tools.

I assume that ZZZZ Manufacturing Ltd. showed immense profits and paid the appropriate corporate USA tax. So American citizens got the tax benefit of a well-run business unit in Canada. With these taxes being lower than what they would have paid in Canada had the profits been reported in Canada, ZZZZ International Ltd. ended up with a higher after-tax profit. ZZZZ International probably didn’t care where it paid taxes; it just wanted to minimize them.

In essence, ZZZZ Manufacturing became a tax minimizing tool for ZZZZ International. If the corporate taxes were higher in the jurisdiction than in the USA, a big premium was added to the cost of the tools. If the jurisdiction had a lower corporate tax rate than the USA, then the tools were sold at cost. By adjusting the cost of the tools for ZZZZ Manufacturing’s “customers,” ZZZZ International always got the benefit of the lower-taxed jurisdiction.

That was a shell game played in the 1980s. ZZZZ accountants figured out how to price oilfield tools to minimize taxes. But the tools were essentially built for internal usage and sales.

Tax minimization tricks are probably much more sophisticated today.
 
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